MSCI Milestone: Chinese Stocks’ Long March to Credibility

*MSCI had rejected previous bids to include Chinese stocks in its indexes, due to the country's opaque regulations and relatively closed market

*Despite finally including Chinese stocks, the company has shown it is still cautious toward them, only listing 226 rather than the 448 it originally proposed

China’s young stock markets gained new global respect on Friday with the first-ever inclusion of their shares in a major global index. But the huge advance was anything but easy for all parties involved.

The addition of 226 Chinese A-shares into the widely watched MSCI Emerging Markets Index marks the end of a long effort by Beijing, whose previous bids were rejected three times during MSCI’s annual reviews starting in 2014. In each of those bids, the U.S.-based index compiler linked to financial services giant Morgan Stanley cited China’s capital controls, opaque regulations and the limited access to foreign investors as factors behind its decision.

China addressed the foreign access issue by launching two stock connect programs that linked the Hong Kong stock market with those in Shanghai and Shenzhen. Those programs allowed investors in the former British colony to access mainland stock markets, allowing them to try out A-share investment.

In the face of its own uncertainty and global investors’ concerns about the move, MSCI also halved the original 448 A-shares it originally proposed for inclusion at the time of an earlier proposal in 2016, and turned more selective by focusing on larger cap stocks over more-volatile small caps.

MSCI’s cautious stance was also evident in its last-minute decision to exclude seven A-shares from its original list, including controversy-plagued telecommunication equipment and smartphone maker ZTE Corp. and four other companies whose shares had been suspended. MSCI also excluded Southwest Securities Co. and Shanghai Construction Co., as the two stocks would no longer be available in the Shanghai-Hong Kong Stock Connect program from June 11, the U.S. index giant said.

Abusive use of trading suspensions in China has long been a concern of investors in general, including MSCI. Such suspensions are relatively easy to get in China, and can often continue for weeks or even months, allowing companies to put off bad news and leaving investors stuck with untradeable shares. MSCI has warned repeatedly since it first made the decision to include A-shares that it will drop companies whose shares are suspended for too long, Caixin reported earlier.

Remaining hurdles that have made the index complier wary include a 30% cap on foreign ownership in any A-share company — a rule that doesn’t apply to domestic investors.

“The restrictions will leave some impact,” said Zhou Wenqun, a Shanghai-based fund manager with Fidelity International. “I think the long-term commitment to open China’s A-share market is complementary to the overall process towards MSCI’s full inclusion. The fewer restrictions on foreign investment, the faster the process will be.”

This story has been corrected to state that a 30% cap is for all foreign ownership in any A-share company, not for a single foreign investor.

Contact reporter Leng Cheng (chengleng@caixin.com)